Applied Rationality focuses on public policy issues and tries to take a liberal perspective that is consistent (comments to the posts will often show otherwise) with neoclassical, rational-choice economics.

Sunday, October 21, 2007

Wal-Mart and wages

An article by Emek Basker in the latest issue of the Journal of Economic Perspectives (subscription required) analyzes the causes, benefits, and consequences of Wal-Mart's phenomenal expansion over the last 40 years. On the plus side, Basker finds that Wal-Mart is a boon to consumers both directly through the lower prices that Wal-Mart itself charges and indirectly through the lower prices that its competitors end up charging. Through technical efficiencies, especially early and continuing computerization, Wal-mart has increased productivity throughout the retail sector.

On the negative side, Wal-Mart hurts the country's trade balance--approximately one-seventh of all of the consumer goods that China exports end up being sold by Wal-Mart stores. The company also has enormous market power in the domestic wholesale market, allowing it to restrict profit margins for its suppliers. Wal-Mart also drives profits down among local competitors and causes some of them to go out of business. Wal-Mart does not appear to add much to job growth. Although a new Wal-Mart will hire lots of workers, these employment gains are typically offset by job losses among other retailers. Finally, it appears that Wal-Mart may lower wages in the labor markets where its stores operate.

One of the really interesting things in all of this is how Wal-Mart can keep its wage costs so low. The business itself is remarkably productive. The company leads the retail industry in terms of output per worker--productivity, efficiency, and size are its primary competitive advantages. Nevertheless, little of this productivity advantage seems to find its way into workers' pockets.

Wal-Mart's checkered labor history is well known. The company has staunchly resisted unionization efforts, using both legal and illegal means. The company has gone so far as to shut down its internal meat-packing operations after a unit in Jacksonville, Texas voted to form a union and closed one of its stores in Quebec after workers there voted to form a union. The company is also facing a discrimination lawsuit filed on behalf of 1.5 million of its female employees (although women make up vast majority of Wal-Mart's hourly employees, they are severely under-represented in Wal-Mart's salaried management ranks, both in absolute terms and relative to other retailers; they are also underpaid relative to men).

But anti-union efforts and possible wage discrimination only take us so far. While the company is large relative to its competitors (in fact, it is the largest employer in the U.S.) and possibly able to affect wages in local labor markets, there still should be competitive pressures that force the company to pay something close to the market-clearing wage. Thus, the very low wages remain something of a puzzle.

One potential explanation for the lower wages is that Wal-Mart may be able to bring the technological and scale advantages from its general operations into its hiring and human resource operations. Low wages usually imply high rates of voluntary (worker-initiated) turnover. Workers who are just entering the job market or who have recently been laid off may be willing to accept low wage employment while they continue to search for something better. Thus, workers come in the door, but they also go out the door as soon as a reasonable alternative shows up. Wal-Mart appears to have reduced many of the "fixed costs" of hiring. Because of the size of the stores, each one has a personnel manager dedicated to recruiting employees. There are streamlined procedures for hiring. There also appear to be relatively low-cost methods for training new employees, including self-paced computer-based learning, self-paced reviews of the employee manual, and coaching from department managers. In other words, if one employee leaves, she can be easily and relatively costlessly replaced.

Low costs of hiring also mean that Wal-Mart can accommodate secondary workers, such as mothers of small children, students, retirees, and moonlighters, who wish to work part-time hours and may be willing to trade some schedule flexibility for pay. Businesses typically face a trade-off between the number of people they hire and the number of hours that each employee works. If the fixed costs of hiring are high, a business will employ fewer people but require them to work full-time schedules. If hiring costs are low (and if productivity doesn't vary much with the number of hours worked), a business can be more flexible and hire more part-timers. This flexibility may allow Wal-Mart to reach further into the lower-paid secondary labor market than its competitors.

Low hiring costs would also allow Wal-Mart to continuously hire employees and then adjust its labor force by firing the least productive, least cooperative, or most expensive workers. Indeed, workers complain that Wal-Mart routinely fires long-tenured employees to make way for less-expensive new workers.

Wal-Mart may also have features that appeal to certain kinds of workers. If Wal-Mart stores are continuously hiring, then workers who want immediate employment will find them appealing. Some people are highly risk averse or are unable to finance a prolonged period of unemployed job search; these people would prefer the "sure thing" of a Wal-Mart job. Along the same lines, Wal-Mart stores represent very stable establishments in a relatively unstable industry. So a Wal-Mart position would offer some measure of job security that other retailers can't match. Risk-averse workers would be willing to trade some salary for near-term job stability.

Wal-Mart should "play fair" in labor markets. That means respecting workers' decisions to organize and paying women and men fairly. However, Wal-Mart appears to have many natural advantages in labor markets that allow it to attract productive workers at low wages. Moreover, the company is known for its ferocious low-cost ethic, which it certainly applies to its labor relations. It would be unreasonable for regulators or local governments to try to strip these advantages away.